Corporate Scandals Continue to Play Out

Stephen DeAngelis

September 27, 2006

The horizontal scenarios created by the corporate scandals of 2001/2002 continue to generate headlines. For example, Dennis Kozlowski, the former Tyco CEO who looted the company’s treasury to fund an extravagant lifestyle, was just given more time to sell his assets in order to raise the $167 million he is required pay in fines and restitution [“Tyco Ex-CEO Gets More Time to Pay Fines,” Associated Press, Wall Street Journal, 25 Sep 2006]. Kozlowski’s partner in crime, former Tyco CFO Mark Swartz, has already paid off his $35 million fine and $37.6 million restitution. Another bad boy in the news is Bernie Ebbers, the former CEO of WorldCom, who began serving a 25-year prison term on 26 September 2001. In a surprising Washington Post article by Carrie Johnson and Brooke A. Masters [“Cook the Books, Get Life in Prison: Is Justice Served?“], the reporters argue that Ebbers is being treated too harshly.

In the category of longest prison sentence, WorldCom Inc. founder Bernard J. Ebbers recently bested the organizer of an armed robbery, the leaders of a Bronx drug gang and the acting boss of the Gambino crime family. … Federal prison policies virtually ensure that Ebbers, who has a heart ailment, will spend the rest of his life in prison for his role in an $11 billion accounting fraud. … The length of Ebbers’s sentence when compared with others touches on one of the most controversial parts of the American criminal justice system: How large a pound of flesh should society exact for serious white-collar crime? When the victims are diffuse, the crime complex and the injuries economic, what kind of punishment constitutes justice? A top executive who gambles his fate at a trial nowadays risks what amounts to a life term for fraud that can involve as little as $2.5 million in losses, said University of Missouri law professor Frank Bowman. Crimes such as first-degree murder, high-level drug dealing and espionage trigger similar recommendations. “That means you have to equate fiddling with the corporate books with first-degree murder or treason,” Bowman said. “My own sense is that any sentence over 20 years for anybody for an economic crime is hard to justify.”

I’d be surprised if middle class investors, who must now spend the rest of their lives trying to recover from financial losses created by people like Kozlowski and Ebbers, feel the same sympathy for Ebbers as Bowman does. Johnson and Masters indicate that investor disgust has not diminished in the years since these companies collapsed.

Public revulsion over financial crimes that cost small investors billions of dollars has barely waned since prosecutors began to investigate a string of corporate scandals in late 2001. The death of convicted Enron founder Kenneth L. Lay in July induced profanity-laden outrage from shareholders who felt they had been “cheated” out of seeing Lay sent to prison. Federal prosecutors seized the mood, imploring Congress this month to pass legislation that would make it easier for them to recover $43.5 million from Lay’s estate, a process that has been seriously complicated by his death. The drive to exact punishment even beyond the grave is a sign of vindictiveness in public officials and shareholders, defense lawyers contend.

As I noted in an earlier post, compliance regulations that stiffened as a result of corporate scandals are not likely to be eased, let alone go away. The fact that those involved in these scandals continue to make headlines is proof enough that companies need to be ever more vigilant in efforts to try and regain the public’s trust. Benefits of automating compliance rule sets include the reducing the opportunities for cooking the books and automatic audit trails. Trusted companies have greater valuation than those whose compliance record is ambiguous.

The corporate scandal fallout has not yet run its course. Carrie Johnson notes in another Washington Post article that Andrew Fastow, the former Enron CFO who was just sentenced to six years in prison, is going to help lawyers representing investors to go after large banks that helped Enron cover up its deceit [“Fastow Takes Aim at Banks He Says Helped Enron,” 26 Sep 2006].

The former executive has said that he viewed banks as “problem-solvers” and that based on conversations he had with certain bankers, certain banks worked with Enron “intentionally and knowingly” to engineer deals that would affect the company’s financial statements and reach technical accounting goals of questionable substance, according to a formal declaration by Fastow to be presented at his sentencing. … A Senate investigations subcommittee and a bankruptcy examiner previously studied the role of banks, which investigators said helped Enron structure billions of dollars in hidden loans and manufacture millions more in cash flow. By aggressively employing accounting tricks, with the assistance of friendly banks, Enron reported $10 billion in debt at the end of 2000, rather than the more accurate figure of $22 billion, according to a 2003 report by examiner R. Neal Batson.

Over $8 billion has already been collected in settlement agreements for Enron investors from banks such as J.P. Morgan Chase & Co., Citigroup Inc., and Bank of America Corporation.  Although courts have dropped Barclays PLC and Deutsche Bank AG from further litigation, lawyers are seeking to have them reinstated as they continue to pursue settlements from Merrill Lynch & Co., the Credit Suisse Group, and the Royal Bank of Scotland Group PLC.

Speaking of lawyers, another Johnson article indicates they seem to be the one group which has emerged virtually untouched from corporate scandals [“Look Who’s Left Standing,” Washington Post, 31 Aug 2006].

Four years after regulators launched a task force to stamp out business corruption, numerous chief executives are on their way to prison, two of the nation’s biggest accounting firms are defunct or on probation, and investment banks have shelled out billions of dollars in settlements. But lawyers serving fraud-ridden companies have emerged relatively unscathed. Unlike the accounting profession, forced by the Sarbanes-Oxley Act in 2002 to submit to independent oversight, lawyers have generally ducked proposals that would have forced them to blow the whistle to outsiders. On an individual level, law firms that dispensed bad advice or failed to act on red flags mostly have avoided prosecution, in contrast to their brethren in the accounting industry. Arthur Andersen LLP met its demise after a 2002 conviction, later overturned, of obstructing justice in the Enron Corp. case. Rival KPMG LLP operates under a form of probation for selling abusive tax shelters.

Generally, the federal government defers to states for monitoring the behavior and ethics of lawyers so regulations governing their actions might not be forthcoming. It could, however, be the last of the horizontal scenarios to play itself out.